Shaw Capital Management August 2010: Financial Markets

Sentiment in the financial markets has improved over

the past month. There has been further evidence that

the recovery in the global economy is continuing; the

sovereign debt crisis in Europe has not yet produced

a major casualty; there has been a modest rally in the

euro; and the Chinese authorities have announced that

they intend to adopt a "more flexible" policy towards

the renminbi that is expected to allow it to appreciate

at a slightly faster rate.



Shaw Capital Management August 2010: Financial Markets - These developments have suggested that the gloom

was overdone. The effect in the currency markets had

been to slightly weaken both the dollar and the yen,

as the "risk appetite" amongst investors and traders

has increased, and to strengthen the commodity-linked

currencies and ease the pressures on the euro.

Sterling has also improved over the month, helped by

the measures announced by the new coalition

government in the UK, both before and during the

recent budget statement, to significantly reduce the

huge fiscal deficit.



Shaw Capital Management views on financial market - But overall movements in the major currencies have

been fairly small, and there is still considerable

optimism about prospects.



The latest evidence on the performance of the US

economy has enhanced the prospects for the dollar,

and this should also continue to provide some stability

for the yen.



The sovereign debt problems in Greece, Spain, Portugal,

and even in Italy, continue to worsen, and may well

lead to defaults and put further pressure on the single

currency system.



There must also be serious doubts about the latest

improvement in sterling.



The new government in the UK is making credible

efforts to reduce the size of the fiscal deficit; but it

faces a daunting task, and will find it very difficult to

maintain its tough stance.



There is therefore a serious risk of a crisis in the UK

currency market, and so it is crucial that the

international agencies prepare contingency measures

to enable them to act quickly if the situation appears

to be running out of control.



The latest available evidence on the performance of

the US economy; show the recovery from recession

remains on track.



Retail sales were 1.2% lower in May than in April,

emphasising the cautious mood amongst consumers;

non-farm payrolls increased by 431,000 in May, but

411,000 jobs were accounted for by temporary

government hiring to complete the 2010 census, leaving

the increase in "real" jobs well below expectations;

new home starts fell sharply in May following the

withdrawal of government measures to prop up the

market, and existing home sales also fel.



And the M3 measure of broad money growth is also

continuing to decline because of weak loan demand

from reliable borrowers, and the reluctance of the

banks to lend to anyone else.

There are offsetting factors in the strength of the

manufacturing sector; and consumer confidence figures

remain reasonably strong.



The Commerce Department has recently revised its

estimate of growth in the first quarter of the year down

to a 3% annualised rate; but this rate may not have

been maintained in the current quarter; and this has

already led to a strong plea to Congress from the

government to authorise additional spending

programmes costing up to $50 billion "to keep the

recovery on track", it is not clear how Congress will

respond.



The Fed chairman, Ben Bernanke’s recently testimony

to Congress; that the pace of the recovery will not be

strong enough to fix the jobs market or reduce the

budget deficit without further help, also argued that,

despite the size of that deficit, "to avoid sharp,

disruptive shifts in spending programmes and tax

policies in the future, and to retain the confidence of

the public and the markets, we should start planning

now how we will meet these budgetary challenges".

This view about the economy is repeated in the

statement after the latest meeting of the bank’s Open

Market Committee, and so, although the bank believes

that the recovery is continuing, it is not surprising that

it is quietly considering what steps it might have to

take if the recovery unexpectedly falters.



There has been a modest recovery in the euro from a

low-point in the early part of the past month, although

it is still ending the period slightly lower.



The economic background in the euro-zone is

continuing to improve, and there has been evidence

of support for the euro, particularly from the Swiss

National Bank, which reported an increase in its foreign

currency reserves of more than $100 billion in May.

But the benefits have been limited by the on-going

sovereign debt problems amongst some member

countries of the euro-zone, and especially by the serious

deterioration in the situation in Spain, and so the

improvement that has occurred remains very fragile.